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It was big news that Sandy Weill recommended re-enacting Glass
Steagall which he helped bring down. People need a history lesson
to realize the lack of Glass Steagall did not cause the 2008
meltdown nor did it prevent the S&L failure of the 1980’s.
Leaving aside the technicalities that used to exist between
S&Ls and commercials banks – S&Ls were even more
restricted in what activities they were able to engage in than
commercial banks even under Glass Steagall. This did not
stop 747 out of 3,234 S&Ls during the 1980’s and 1990’s from
failing and around another 1,000 from disappearing through
mergers with regulators’ assistance mostly allowing goodwill to
be counted as tangible capital. While some blame the relaxation
of these restrictions in 1980 and 1982 for the S&L crisis,
people forget these bills were passed to help the S&Ls “grow”
out of an already existing problem, the alternative being the
federal government would have to bailout the deposit base even
sooner. The core problems of the S&Ls were they restricted in
what interest rates they could offer in high inflationary times,
and saw deposits flee to money markets and most importantly they
were “upside-down” on the mortgage portfolios because they had
lent long term at fixed rates and were now having to offer higher
interest rates to maintain deposits. They had a classic
asset-liability mismatch – funding 30 year mortgages with short
term deposits. There were even state chartered S&Ls that were
not allowed to offer adjustable rate mortgages to help deal with
this asset-liability mismatch, until reforms were adopted.

It is worth noting that money markets which have gotten little
attention during both the S&L crisis and the 2008 crisis are
actually at the center of both of them and their mere existence a
major reason why Glass Steagall was repealed. The money
markets siphoning off S&L deposits had to have a means
to offer those higher interest rates. What they had was
commercial paper. Commercial paper was not only the instrument
that money markets used to distintermediate federally insured
depository institutions (both banks and S&Ls) from their
deposit base, it was the instrument used to disintermediate
commercial banks from the corporate lending clients who used
commercial paper instead of bank loans. In plain English, if IBM
or GM needed some short term money rather than going to Chase
Manhattan for a loan they would ask Goldman Sachs to float some
commercial paper. It is also worth noting that a run on
money markets caused by Reserve Fund one of the oldest money
markets in the country “breaking the buck” did more to bring us
close to a complete collapse than anything at any bank.

People need to familiarize themselves with term and concept of
disintermediation if they want to discuss regulation. You can’t
argue for regulation without having a plan to deal with
non-regulated or less regulated entities from competing with
banks. We need to remember that the bulk of the problem
home loans that took us to brink of the disaster originated with
non-bank financial institutions like Countrywide. Before
Glass-Steagall was formerly repealed, it was dramatically
weakened by regulatory exemptions, many given to combat the
disintermediation issue. This also raises the issues if
Glass-Steagall were to be re-enacted, should regulatory
exemptions be allowed? – because these exemptions had pretty much
gutted the law, particularly the division between commercial
banking and investment banking activities even before the passage
of Gramm-Leach-Bliley. Has Sandy Weill not wanted Citicorp to buy
an insurance company (Travelers), Glass-Steagall would still
nominally be on the books, but nothing that took place in the
second half of last decade would have been precluded if the
weakened Glass-Steagall had still be in effect.

Glass-Steagall didn’t preclude banks from purchasing risky
securities, it only prohibited them from underwriting them.
Hence, the multibillion loss at JP Morgan from the “London Whale”
could have occurred even under the Glass-Steagall act as
originally enacted in 1933. Except for of course there were no
credit default swaps then to speculate in.